Global Funds Gain After AIJ Rattles Japan’s Pensions

Global hedge funds are adding
Japanese assets after local manager AIJ Investment Advisors Co.
unnerved the retirement market by seeking to hide $1 billion in
losses from its pension-fund clients.

Neuberger Berman Group LLC is winning new mandates to the
$4 billion it has gathered in Japan since 2004. Winton Capital
Management Ltd., with about $3 billion from Japanese investors,
is seeing steady inflows, while Financial Risk Management Ltd.
is starting a new fund to meet growing interest.

“We have seen an increase in inquiries from our clients,
including Japanese pensions,” said Motoyuki Sato, who runs one
of FRM’s fund of hedge funds. “It is unfortunate some pension
funds had invested in AIJ, but it seems that they are still
looking at alternative investments, including equity long-short
products, as a way to diversify.”

Japanese pensions oversee $3.36 trillion, the world’s
second-largest pool of retirement assets, according to Towers
Watson & Co. They are pumping more money into alternative
investments such as hedge funds in a bid to cope with domestic
bond yields that are among the world’s lowest, two decades of
slumping stocks and a rapidly aging population. Twenty-one
percent of retirement funds plan to boost alternative
investments in the fiscal year started April 1, the most among
10 asset classes, a May survey by JPMorgan Chase & Co. showed.

AIJ President Kazuhiko Asakawa was among four people
arrested on suspicion of fraud today, a Tokyo Metropolitan
Police Department spokeswoman said on condition of anonymity,
citing police policy. They allegedly defrauded pension funds in
Tokyo and Nagano Prefecture of about 7 billion yen ($89
million), the person said.

Beating Nikkei

Asakawa admitted in parliamentary testimonies earlier this
year to disguising the losses, adding that he didn’t intend to
lie to clients.

The Eurekahedge Hedge Fund Index, tracking more than 2,700
funds globally, has beaten the Nikkei 225 (NKY) Stock Average every
year since 2006. The hedge-fund index is up 1.8 percent this
year through May, compared with the Nikkei’s 1 percent advance,
while Japan’s sovereign bonds returned 1.4 percent, according to
Bank of America Corp.’s Merrill Lynch index.

Hedge funds are private partnerships that cater to the
wealthy and institutions, and seek to profit regardless of the
direction of financial markets. The managers of the largely
unregulated pools of capital can bet on falling asset prices,
known as shorting, as well as on rising values.

Pension Review

AIJ, based in Tokyo, managed 145.8 billion yen of clients’
money and lost 109.2 billion yen from derivatives trades over
nine years, the Securities and Exchange Surveillance Commission
said March 23. The fallout, after the financial watchdog ordered
the firm suspend operations in February, led to Japan’s biggest
review of the fund industry and retirement funds’ investment
practices.

The Ministry of Health, Labour and Welfare, which oversees
the pension industry, plans a new set of guidelines to prevent a
similar scandal by the end of June. Proposed measures include
limits on allocations to single managers after some pension
funds had invested more than half their assets with AIJ, a draft
report by the ministry showed.

AIJ’s clients were small retirement plans, including taxi
drivers and cooperatives, with little financial capacity to hire
consultants or investment professionals.

‘Greater Receptivity’

“The Japanese pension market is showing a greater
receptivity to foreign funds,” said Eric Weinstein, chief
investment officer of Neuberger Berman’s fund-of-hedge-funds
business in New York. “This increased receptivity gives pension
funds a broader set of investment choices, so they will be
better able to achieve their investment objectives.”

Neuberger Berman continued to win hedge fund investment
mandates from Japanese investors following AIJ, he said. The New
York-based investment company, which bought itself from Lehman
Brothers Holdings Inc. after the investment bank filed for the
largest bankruptcy in U.S. history in 2008, had about $193
billion under management as of Dec. 31.

About half of Japan’s pension assets are managed by local
trust banks, according to Hidenori Suzuki, head of the strategic
advisory group at JPMorgan Asset Management (Japan) Ltd. in
Tokyo. The nation’s insurers and asset managers handle about a
quarter, while foreign institutions oversee the rest. About 80
percent of hedge-fund investments by pensions are managed by
foreign firms, including those that offer conventional products
such as stock and bond funds, he said.

Assets Rise

Alternative investments, including hedge funds and real
estate, accounted for 9.7 percent of Japanese pension fund
assets as of March 2012, according to the JPMorgan survey. That
compares with 7.1 percent in March 2009. The average assets
managed by Japanese hedge funds are estimated at $71 million,
compared with $257 million by North American managers and a
global average of $174 million, according to Eurekahedge Pte, a
Singapore-based data provider.

Pensions are becoming more selective, choosing larger
international managers with proven track records as a result of
the AIJ scandal, said Jiro Shimpo, director of alternative
investment consulting for Japan and Northeast Asia at Russell
Investments in Tokyo.

“There is a natural preference for bigger, more
established funds, more as a process of elimination,” he said.
“We’re seeing many European managers visit, seeking to entice
Japanese pensions.”

Inexperienced Managers

Japan’s pension market trails only the U.S.’s $16.1
trillion, according to Towers Watson. About 80 trillion yen of
pension money in Japan is in corporate plans, according to data
from the health ministry.

About 90 percent of managers under Japan’s employee pension
system had no prior experience overseeing assets, a government
survey conducted following the AIJ fallout showed. Only 2
percent of managers at the 558 retirement plans were certified
as analysts at a brokerage or financial planners, according to
the survey. Those who had worked at financial institutions made
up about 3 percent.

Japanese pensions are now returning to fund of hedge funds,
which had fallen out of favor after the collapse of Lehman
Brothers forced many to limit investor withdrawals, said Michael van Biema, founder of van Biema Value Partners LLC, a New York-
based fund of hedge funds with about $800 million. Fund of hedge
funds spread investors’ money across a variety of holdings,
charging fees on top of the 2 percent of assets and 20 percent
of gains that typically go to the underlying funds.

Pendulum Swings

“The pendulum had swung all the way away from fund of
funds and now the pendulum is swinging back,” he said. “One of
the reasons that allocators use funds of funds is to fill in the
holes of their expertise, and that’s a valid use of the FOFs
model, assuming that FOFs do have the expertise. Doing it
yourself is not always the best solution.”

FRM, an $8 billion U.K. fund of hedge funds that has agreed
to be taken over by Man Group Plc, teamed with Sumitomo Mitsui
Trust Holdings Inc. in April to offer a pool that invests in
managers that trade Japanese stocks. FRM JELS began with about
$19 million and expects to reach about $100 million in the next
couple of months through new allocations from Japanese pensions,
said Sato, the manager of the fund.

“We’re seeing demand for fund-of-hedge-funds products
because of the due diligence capacity that’s been under the
spotlight with the latest AIJ case,” said Sato. “We’re hoping
that that service will provide some comfort to our clients.”

‘Steady Inflows’

For London-based Winton, Japan is the second-largest market
after the U.S., accounting for about 10 percent of its $30
billion of assets, according to the manager. In Japan, about
$650 million has been raised from pensions, primarily through
Daiwa Asset Management Co., according to Winton.

“AIJ has not affected any inflows from pension funds,”
said Charles Allard, head of Asian sales at Winton. “We haven’t
seen people who were planning to invest not invest. We continue
to have some steady inflows into the funds from Japanese pension
funds.”

Japan’s pensions have been slow to embrace hedge funds,
with 2.2 percent of assets allocated to the partnerships,
according to data compiled by London-based research firm Preqin
Ltd. U.S. funds account for 60 percent of hedge-fund
investments, and Europe for 29 percent.

Domestic bond holdings, which make up the biggest asset
class for Japan’s retirement funds, declined to 31.7 percent of
pensions surveyed by JPMorgan as of March, from 34.4 percent
three years ago.

Diversify Portfolios

The 10-year Japanese government bond yield is 0.8 percent,
the second lowest after Switzerland. The Nikkei is less than a
quarter of its 1989 peak.

“Because the Japanese stock market hasn’t performed very
much for a long time, both individual and pension funds
increasingly need to diversify their portfolios,” said Winton’s
Allard. “Pension funds across the world are realizing that they
have to put money into alternatives. In the end, it’s about
performance and what you’re offering and whether people want to
diversify their portfolio.”

The pension of Hitachi Kokusai Electric Inc., a unit of
Hitachi Ltd., Japan’s second-largest manufacturer, will almost
double its allocation to hedge funds this fiscal year to 15
percent from 8 percent, said Kazuaki Sakura, the fund’s adviser.